E4-10

Correct.

Mallory Luongo, Inc. manufactures five models of kitchen appliances at its Mesa plant. The company is
installing activity-based costing and has identified the following activities performed at its Mesa plant.
Having analyzed its Mesa plant operations for purposes of installing activity-based costing, Mallory
Luongo, Inc. identified its activity cost centers. It now needs to identify relevant activity cost drivers in
order to assign overhead costs to its products. Using the activities listed below, identify for each
activity one or more cost drivers that might be used to assign overhead to Mallory Luongo's five
products. (If several answers appear right, select the answer that lists all the cost drivers
that might be used.)
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Designing new models.

Number of engineering change orders; Hours of designing

Purchasing raw materials and

parts.

Number of orders processed

Storing and managing

inventory.

Number of parts in stock

Receiving and inspecting raw

materials and parts.

Weight of material; Number of boxes or cartons

Interviewing and hiring new

personnel.

Employee turnover; Number of employees hired

Machine forming sheet steel

into appliance parts.

Machine hours; Direct labor hours

Manually assembling parts into

appliances.

Number of employees; Number of parts; Direct labor hours

Training all employees of the

company.

Number of employees

Insuring all tangible fixed

assets.

Book or market value of assets

Supervising production.

Cost of goods manufactured; Direct labor hours; Number of employees

11. Maintaining and repairing

machinery and equipment.

Machine hours; Number of machines

12. Painting and packaging finished

appliances.

Gallons of paint; Number of appliances

E4-11 (a,b)
Sorce Instrument, Inc. manufactures two products: missile range instruments and space pressure
gauges. During April, 50 range instruments and 300 pressure gauges were produced, and
overhead costs of $89,500 were estimated. An analysis of estimated overhead costs reveals the

following activities.
Activity

Cost Driver

1. Materials handling
2. Machine setups

Number of requisitions
Number of setups

3. Quality inspections

Number of inspections

Total Cost
$35,000
27,500
27,000
$89,500

The cost driver volume for each product was as follows.

Cost Driver
Number of requisitions
Number of setups
Number of inspections

Instruments
400
200
200

Gauges
600
300
400

Total
1,000
500
600

Correct.

Determine the overhead rate for each activity.

Materials handling
Machine setup
Quality inspections

$
35

$
55

$
45

SHOW SOLUTION
SHOW ANSWER

Correct.

Assign the manufacturing overhead costs for April to the two products using activity-based
costing.

Instruments per unit

Gauges per unit

$
680

$
185

P4-3A (a,c)
Skaros Stairs Co. of Moore designs and builds factory-made premium wooden stairs for homes.
The manufactured stair components (spindles, risers, hangers, hand rails) permit installation of
stairs of varying lengths and widths. All are of white oak wood. Budgeted manufacturing overhead
costs for the year 2011 are as follows.
Amount

Overhead Cost Pools

Purchasing
Handling materials
Production (cutting, milling, finishing)
Setting up machines
Inspecting
Inventory control (raw materials and finished goods)
Utilities
Total budget overhead costs

$ 57,000
82,000
210,000
85,000
90,000
126,000
180,000
$830,000

For the last 4 years, Skaros Stairs Co. has been charging overhead to products on the basis of
machine hours. For the year 2011, 100,000 machine hours are budgeted.
Anthony Morse, owner-manager of Skaros Stairs Co., recently directed his accountant, Neal
Seagren, to implement the activity-based costing system that he has repeatedly proposed. At
Anthony Morse's request, Neal and the production foreman identify the following cost drivers and
their usage for the previously budgeted overhead cost pools.

Activity Cost Pools

Purchasing
Handling materials
Production (cutting, milling, finishing)
Setting up machines
Inspecting
Inventory control (raw materials and finished goods)
Utilities

Cost Drivers
Number of orders
Number of moves
Direct labor hours
Number of setups
Number of inspections
Number of components
Square feet occupied

Expected
Use of
Cost Drivers
600
8,000
100,000
1,250
6,000
168,000
90,000

David Hannon, sales manager, has received an order for 280 stairs from Community Builders,
Inc., a large housing development contractor. At David's request, Neal prepares cost estimates for
producing components for 280 stairs so David can submit a contract price per stair to Community
Builders. He accumulates the following data for the production of 280 stairways.
Direct materials

$103,600

Direct labor
Machine hours
Direct labor hours
Number of purchase orders
Number of material moves
Number of machine setups
Number of inspections
Number of components
Number of square feet occupied

$112,000
14,500
5,000
60
800
100
450
16,000
8,000

Correct.

Compute the predetermined overhead rate using traditional costing with machine hours as the
basis. (Enter answer to 2 decimal places, e.g. 10.50.)
$

per machine hour.

8.30

SHOW SOLUTION
SHOW ANSWER

Correct.

What is the manufacturing cost per stairway under traditional costing? (Use rounded amount
from part (a). Round answer to 2 decimal places, e.g. 10.50.)
Cost per stair $
1,199.82

SHOW SOLUTION
SHOW ANSWER

Correct.

What is the manufacturing cost per stairway under the proposed activity-based costing? (Round
activity-based overhead rates to 2 decimal places, e.g. 10.50. Round final answer to 2
decimal places, 10.50.)
Cost per stair $
1,005.54

P4-3A (d)
Skaros Stairs Co. of Moore designs and builds factory-made premium wooden stairs for homes. The
manufactured stair components (spindles, risers, hangers, hand rails) permit installation of stairs of
varying lengths and widths. All are of white oak wood. Budgeted manufacturing overhead costs for the
year 2011 are as follows.
Amount

Overhead Cost Pools

Purchasing
Handling materials
Production (cutting, milling, finishing)
Setting up machines
Inspecting
Inventory control (raw materials and finished goods)
Utilities
Total budget overhead costs

$ 57,000
82,000
210,000
85,000
90,000
126,000
180,000
$830,000

For the last 4 years, Skaros Stairs Co. has been charging overhead to products on the basis of
machine hours. For the year 2011, 100,000 machine hours are budgeted.
Anthony Morse, owner-manager of Skaros Stairs Co., recently directed his accountant, Neal
Seagren, to implement the activity-based costing system that he has repeatedly proposed. At Anthony
Morse's request, Neal and the production foreman identify the following cost drivers and their usage
for the previously budgeted overhead cost pools.

Activity Cost Pools

Purchasing
Handling materials
Production (cutting, milling, finishing)
Setting up machines
Inspecting
Inventory control (raw materials and finished goods)
Utilities

Cost Drivers
Number of orders
Number of moves
Direct labor hours
Number of setups
Number of inspections
Number of components
Square feet occupied

Expected
Use of
Cost Drivers
600
8,000
100,000
1,250
6,000
168,000
90,000

David Hannon, sales manager, has received an order for 280 stairs from Community Builders, Inc., a
large housing development contractor. At David's request, Neal prepares cost estimates for producing
components for 280 stairs so David can submit a contract price per stair to Community Builders. He
accumulates the following data for the production of 280 stairways.
Direct materials
Direct labor
Machine hours
Direct labor hours
Number of purchase orders
Number of material moves
Number of machine setups
Number of inspections
Number of components
Number of square feet occupied

$103,600
$112,000
14,500
5,000
60
800
100
450
16,000
8,000

Which of the two costing systems is preferable in pricing decisions and why? Refer to P4-3A (a-c).

The difference between the traditional cost and the activity-based cost per unit,
$1,199.82 versus $1,005.54, is not great in amount but $194.28 or ($1,199.82
$1,005.54) is 19.3% of the more correct ABC cost per unit. Activity-based costing is
the preferable costing system for setting prices because the real costs are more
accurately reflected. The greater accuracy is a result of multiple, more relevant
activity cost drivers under ABC than the single cost driver used with the traditional
volume-based system.

P4-4A (a-d)
Polzin Corporation produces two grades of wine from grapes that it buys from California growers.
It produces and sells roughly 3,000,000 liters per year of a low-cost, high-volume product called
CoolDay. It sells this in 600,000 5-liter jugs. Polzin also produces and sells roughly 300,000 liters
per year of a low-volume, high-cost product called LiteMist. LiteMist is sold in 1-liter bottles.
Based on recent data, the CoolDay product has not been as profitable as LiteMist. Management is
considering dropping the inexpensive CoolDay line so it can focus more attention on the LiteMist
product. The LiteMist product already demands considerably more attention than the CoolDay
line.
Greg Kagen, president and founder of Polzin, is skeptical about this idea. He points out that
for many decades the company produced only the CoolDay line, and that it was always quite
profitable. It wasn't until the company started producing the more complicated LiteMist wine that
the profitability of CoolDay declined. Prior to the introduction of LiteMist, the company had simple
equipment, simple growing and production procedures, and virtually no need for quality control.
Because LiteMist is bottled in 1-liter bottles, it requires considerably more time and effort, both to
bottle and to label and box than does CoolDay. The company must bottle and handle 5 times as
many bottles of LiteMist to sell the same quantity as CoolDay. CoolDay requires 1 month of aging;
LiteMist requires 1 year. CoolDay requires cleaning and inspection of equipment every 10,000
liters; LiteMist requires such maintenance every 600 liters.
Greg has asked the Accounting department to prepare an analysis of the cost per liter using
the traditional costing approach and using activity-based costing. The following information was
collected.

Direct materials per liter

Direct labor cost per liter

CoolDay
$0.40
$0.25

LiteMist
$1.20
$0.50

Direct labor hours per liter

Total direct labor hours

Activity Cost Pool

Grape processing
Aging
Bottling and corking
Labeling and boxing
Maintain and inspect
equipment

Cost Driver
Cart of grapes
Total months
Number of
bottles
Number of
bottles
Number of
inspections

0.05
150,000

0.09
27,000

Estimated
Overhead

Expected
Use of
Cost
Drivers

Expected Use of
Cost Drivers per
Product
CoolDay

LiteMist

$145,860
396,000

6,600
6,600,000

6,000
3,000,000

600
3,600,000

270,000

900,000

600,000

300,000

189,000

900,000

600,000

300,000

800

350

450

240,800
$1,241,660

Correct.

Under traditional product costing using direct labor hours, compute the total manufacturing cost
per liter of both products. (Round computations and final answers to 3 decimal places,
e.g. 2.250.)

CoolDay
LiteMist

$
1.001

$
2.331

SHOW SOLUTION
SHOW ANSWER

Correct.

Under ABC, prepare a schedule showing the computation of the activity-based overhead rates
(per cost driver). (Enter overhead rate to 2 decimal places, e.g. 10.50.)

Activity Cost
Pools

Grape processing
Aging
Bottling and
corking
Labeling and
boxing
Maint. & inspect
equip.

Estimated
Overhead

Expected Use
of Cost Drivers

Activity-Based Overhead Rate

$
22.10

per cart

6,600,000

.06

per month

270,000

900,000

.30

per bottle

189,000

900,000

.21

per bottle

240,800

800

301.00

145,860

6,600

396,000

per
inspection

SHOW ANSWER

Correct.

Prepare a schedule assigning each activity's overhead cost pool to each product, based on the
use of cost drivers. What is the overhead cost per liter? (Enter overhead rate to 2 decimal
places, e.g. 10.50 and round overhead cost per liter to 3 decimal places, e.g. 2.250.)
CoolDay

Activity Cost Pools

Expected Use
of Cost Drivers

Grape processing

6,000

Aging

Activity-Based
Overhead Rates
$

Cost Assigned
$

22.10

132,600

3,000,000

.06

180,000

Bottling and corking

600,000

.30

180,000

Labeling and boxing

600,000

.21

126,000

Maint. & inspect equip.

350

301

105,350

$
723,950

Total costs assigned

Liters produced

3,000,000

$
.241

Overhead cost per liter

LiteMist

Activity Cost Pools

Expected Use
of Cost Drivers

Grape processing

600

Aging

Activity-Based
Overhead Rates

Cost Assigned

$
22.10

13,260

3,600,000

.06

216,000

Bottling and corking

300,000

.30

90,000

Labeling and boxing

300,000

.21

63,000
135,450

Maint. & inspect equip.

450

301

$
517,710

Total costs assigned

300,000

Liters produced

$
1.726

Overhead cost per liter

SHOW ANSWER

Correct.

Compute the total manufacturing cost per liter for both products under ABC. (Round answers

to 3 decimal places, e.g. 2.250.)

$

CoolDay

.891

LiteMist

3.426

SHOW SOLUTION
SHOW ANSWER

P4-4A (e)
Your answer has been saved and sent to the instructor. See Gradebook for score details.

Polzin Corporation produces two grades of wine from grapes that it buys from California growers. It
produces and sells roughly 3,000,000 liters per year of a low-cost, high-volume product called
CoolDay. It sells this in 600,000 5-liter jugs. Polzin also produces and sells roughly 300,000 liters per
year of a low-volume, high-cost product called LiteMist. LiteMist is sold in 1-liter bottles. Based on
recent data, the CoolDay product has not been as profitable as LiteMist. Management is considering
dropping the inexpensive CoolDay line so it can focus more attention on the LiteMist product. The
LiteMist product already demands considerably more attention than the CoolDay line.
Greg Kagen, president and founder of Polzin, is skeptical about this idea. He points out that for
many decades the company produced only the CoolDay line, and that it was always quite profitable. It
wasn't until the company started producing the more complicated LiteMist wine that the profitability of
CoolDay declined. Prior to the introduction of LiteMist, the company had simple equipment, simple
growing and production procedures, and virtually no need for quality control. Because LiteMist is
bottled in 1-liter bottles, it requires considerably more time and effort, both to bottle and to label and
box than does CoolDay. The company must bottle and handle 5 times as many bottles of LiteMist to
sell the same quantity as CoolDay. CoolDay requires 1 month of aging; LiteMist requires 1 year.
CoolDay requires cleaning and inspection of equipment every 10,000 liters; LiteMist requires such
maintenance every 600 liters.
Greg has asked the Accounting department to prepare an analysis of the cost per liter using the
traditional costing approach and using activity-based costing. The following information was collected.

Direct materials per liter

Direct labor cost per liter
Direct labor hours per liter
Total direct labor hours

Activity Cost Pool

Grape processing
Aging

CoolDay
$0.40
$0.25
0.05
150,000

Cost Driver
Cart of grapes
Total months

LiteMist
$1.20
$0.50
0.09
27,000

Estimated
Overhead
$145,860
396,000

Expected
Use of
Cost Drivers
6,600
6,600,000

Expected Use o
Cost Drivers per Pro
CoolDay
6,000
3,000,000

Lite

3,60

Bottling and corking

Labeling and boxing

Number of bottles
Number of bottles

Maintain and inspect

equipment

Number of inspections

270,000
189,000
240,800

900,000
900,000

600,000
600,000

800

350

$1,241,660

Write a memo to Greg Kagen discussing the implications of your analysis for the company's plans. In
this memo provide a brief description of ABC, as well as an explanation of how the traditional
approach can result in distortions. Refer to P4-4A (a-d).

To:

Greg Kagen

From:

Student name

Subject: Product costs using ABC versus traditional approach

The memorandum covers the following points:
a) ABC allocates overhead costs as a function of each products use of cost
drivers. Thus, ABC results in overhead allocation that more closely approximates
each products generation of overhead costs.
b) Traditional approaches that allocate costs as a function of volume tend to be
biased toward allocating too much overhead to high volume, simple products, and
too little to low volume, complex products. This is because the actual incurrence of
overhead costs is rarely correlated with labor costs.
c) In the case of the Mendocino Corporation, the LiteMist product required the
company to begin using more complex methods and equipment. Overhead costs
increased substantially. When overhead costs were allocated using labor rates, too
much overhead was allocated to the high volume CoolDay product. This reduced the
apparent profitability of this product.
d) The total cost of the two products under the two approaches was as follows:
CoolDay
LiteMist
Traditional approach
ABC

$1.001

$2.331
$0.891

$3.426

Therefore, the relative profitability of the two products should be determined

using ABC costing.

30
30